You had perfectly good reasons for being cowardly about the stock market in 2012, but caution didn't serve you well.
Despite the fear that a eurozone breakup and a European bank infection would set off another global financial crisis ... despite the fear that China had overdone it with real estate construction and was on its way to a hard landing ... and despite the fretting over ingrained unemployment in the U.S., the Standard & Poor's 500 index ended the year up 13.4 percent, at 1,426. The Dow Jones industrial average gained 7.3 percent for the year and closed Monday at 13,104, up 166 points as news of a possible "fiscal cliff" compromise emerged.
It's evidence that the economy and the stock market can be on very different paths.
The S&P 500 still hasn't regained all that was lost between late 2007 and March 2009, when it plunged 57 percent, to 676, but it's getting close. The index has climbed more than 100 percent since the fearful days of the financial crisis but remains below its Sept. 24, 2007, high of 1,526. With the benefit of dividends, investors have recovered what they lost.
The 13.4 percent gain in 2012 was no small feat for a year when economists worried repeatedly about the globe dipping back into recession. An average year in the stock market provides investors with a gain of 9.8 percent. Despite the unusual strength of stocks, the U.S. economy remained lackluster — growing at about 2 percent rather than the 4 percent economists say is necessary to get Americans back into jobs.
Now, analysts are debating whether stocks have climbed too high, given ongoing risks in the economy worldwide and moves toward austerity in the U.S. and Europe as governments move toward dealing with their debts. Others argue that if U.S. lawmakers can finally move past the squabbling and phase in tax increases and spending cuts, the stock market will rally in relief.
"The global economy stumbles into 2013," said economist Ethan Harris of Bank of American Merrill Lynch. He doesn't think the "uncertainty shock" of the fiscal cliff will be resolved until spring.
The most nerve-wracking days of the year came in the second quarter, as economists worried that Spain would not be able to raise the money the government needed without paying exorbitant interest rates, and European banks were threatened by investments in government bonds plunging in value. Meanwhile, many economists thought Greece was so buried in debt it would have no way out without leaving the euro — a prospect that analysts thought would set off economic chaos in Europe and investor fear worldwide. And China slowed as Europe's recession interfered with demand for China exports.
Despite reluctance by political leaders in strong countries such as Germany to help struggling countries such as Spain and Greece, bailouts were offered. The European Central Bank provided relief to eurozone banks and governments by purchasing the equivalent of their Treasury bonds. That kept borrowing costs manageable for Spain and Italy, averting a crisis for the governments.
IHS Global Insight economist Nariman Behravesh predicts that the "the economies of southern Europe will remain deep in recession territory" as they grapple with austerity and high unemployment. Both Greece and Spain have unemployment of more than 25 percent, or rates slightly higher than the U.S. had during the Great Depression.
The turning point in jittery stock markets came when bailouts were provided, and especially when European Central Bank President Mario Draghi promised in July to do "whatever it takes" to keep the eurozone together. With U.S. Federal Reserve Chairman Ben Bernanke also providing another round of stimulus known as "quantitative easing," investors worldwide lived by a common investor slogan: "Don't fight the Fed."
In other words, when central banks like the Federal Reserve are pouring money into the system, investors usually buy stocks. Europe's Stoxx 600 index climbed 14.4 percent for the year, and German stocks climbed more than 29 percent for the year.
In the U.S., financial companies and stocks that rely on consumers spending on non-necessities did best. Financial stocks rose 25 percent, and consumer discretionary companies climbed 20 percent.
"Risk paid off handsomely," said Citigroup strategist Tobias Levkovich. Although investors sought the safety of utility stocks while worried about a slowing global economy in the second quarter, that changed when bailouts and stimulus arrived in the summer. Utilities were the worst performers of the year, declining 4.2 percent — in part, because investors became concerned about higher dividend taxes during the fiscal cliff debate.
Individual investors remained cautious throughout the year. According to Thomson Reuters' Lipper, they pulled $87.3 billion out of U.S. stock mutual funds during the year, while pouring $300.7 billion into U.S. bond funds. They ignored warnings that bond funds would decline in value if interest rates began climbing. The yield on a 10-year Treasury bond remained near historic lows at 1.7 percent, or slightly lower than the 1.88 percent a year ago. Since 2008, Lipper says investors have pulled $388.9 billion out of stock funds and added more than $1 trillion to bond funds.